In a recent talk at the U.S. Monetary Policy Forum, Bank of Canada Governor Mark Carney argued that there wasn’t much to be gained from moving away from a low inflation target:

Finally, some have argued that an inflation target consistent with price stability is too low for a post-crisis world.

While the recovery is proceeding in crisis economies, it remains weak, particularly relative to the depth of the recession. This is consistent with the historical experience following financial crises. Indeed, it is only with justified comparisons to the Great Depression that the success of the U.S. policy response is apparent.

Read that last line several times, and just think about what he is actually saying. Do you feel better now?

As Woodfordian logic would have it, a key appeal of NGDP-level targeting is that by compensating for past deviations from desired levels–i.e., by introducing more dependence on history–it would better harness the power of expectations to stabilize the economy.

In normal times, these greater stabilization benefits are not likely to be particularly important. As part of the work leading to the renewal of our inflation control agreement, the Bank of Canada analysed the benefits of price-level targeting (PLT) which, like nominal GDP targeting, is a way to introduce history dependence. Our research shows that, apart from lower bound episodes, the gains from better exploiting the expectations channel are likely to be modest.

Hence the title of this post. Bill Woolsey pointed me to this gem:

In addition, under NGDP-level targeting, the central bank would seek to stabilize the GDP deflator in order to achieve price stability. But the GDP deflator measures the price level of domestically produced goods and services, which may not match up well with the cost of living that the CPI measures and that matters most for welfare, particularly in small, open economies where imports make up a substantial share of the consumption basket.

Looks like we need to modify our textbooks where they cover the “welfare costs of inflation.” Now we need to add: “Stuff costs more when people go shopping.”

Just so I don’t come across as too negative, let me congratulate the Canadians for avoiding the iceberg that we struck, and for successfully managing a flexible inflation targeting regime for several decades. I still think NGDP targeting would be slightly better for Canada, but concede it’s a close call. So there’s always the “if it ain’t broke don’t fix it” argument. But for America it’s not even a close call. We are doing significant fiscal stimulus that is highly costly (such as the payroll tax cut) precisely because our monetary policy regime is widely seen as producing inadequate nominal expenditure. In America it is broke. We are likely to hit many more zero bounds, as the Wicksellian equilibrium real rate seems to have shifted to a permanently lower level in this century. And yet the Fed still doesn’t seem to understand that fact.

If it makes people “comfortable”, do NGDP Level Targeting under the rubric “Flexible Inflation Target”. If the problem is that “potential” output can change, so that NGDPT contemplates permanently higher inflation, using the “Flexible IT” strategy permits you to correct the original NGDPT down, so that inflation comes back to “Target”. You suggested something along those lines in your recent post “Bernanke favors NGDP targeting, he just doesn´t realize it”.

“But the GDP deflator measures the price level of domestically produced goods and services, which may not match up well with the cost of living that the CPI measures and that matters most for welfare, particularly in small, open economies where imports make up a substantial share of the consumption basket.”

Amazing. So the top priority of the Bank of Canada is keeping the US, Japan, and Europe in recessions so commodity prices remain low? He’s certainly getting his wish. We should check Bernanke’s bank records for unexplained transfers from Canada. He’s fulfilling his Canadian mandate almost too perfectly. Come to think of it, didn’t New Zealand, another small open economy, pioneer inflation targeting, which arguably caused the passive tightening in 2008 as gas prices rose? I guess our malevolent puppet masters really are central bankers, just not the obvious ones.

I think marcus nunes’s suggestion is actually a good way to operationalize the “flexible” part of flexible IT/PLT. This would make our monetary choices less discretionary, more predictable and less dependent on uncertain estimates of potential output.

I’m less clear on whether we should care about the distinction between the CPI and the GDP deflator, but one would think it easy enough to fix Scott’s proposal by using either the PCE deflator or the CPI as a deflator for NGDP.

We need an expansionary monetary policy, not a Bank of Japan-style suffocation.

A peevish fixation on inflation—really an unhealthy obsession—does not make a monetary policy. We have seen what the Theo-Monetarists and Econo-Shamans have done to Japan. In 20 years they have had tight money, and real wages down 15 percent, industrial production down 20 percent, property values down 80 percent and the stock market down 75 percent. You like those apples? Why?

The yen soared—yippee. They have a “strong yen.” Big whoop. They had mild deflation all the way. The facts are that even mild deflation is a growing cancer on a modern economy–that is the empirical record, not a theory.

Why are professional economists so obsessed with inflation? Why such a failing of the profession?

Tight money—tight enough to cause deflation—is an epic failure. It just does not work.

The Market Monetarists have the right take–you need a monetary policy that supports growth and expansion. Moderate inflation is hardly the end of the world, if I can obtain steady growth. I’ll take that deal any day, all day, and for the rest of my life.

From 1982 to 2008, USA industrial production doubled, and all the while we had inflation in the 2 percent to 6 percent range (CPI). Oh, such misery–I wish for such misery all the time. Our lowest inflation in recent times was from 2008-2011, at less than 1.5 percent on the CPI. Great times, no? Such are the glories of deflation and very low inflation.

I advise economists to rather than freakishly obsess on a nominal index, become obsessed with what causes growth. Do not genuflect to gold or worship “sound” currency. Worship growth, robust growth and more growth.

Should not growth be the target of macroeconomics?

Add on: The Chicken Inflation Littles rant about inflation—but how does one even measure inflation? Hard-core righties like Don Boudreaux of George Mason have written the CPI and other measures are geared to overstate inflation.

We live in a world of rapidly evolving goods and services. I have a camera that can take 1000 digitals and then send them to Thailand immediately, for zero marginal cost. A generation ago, that would have cost thousands of dollars for developing the film and subsequent airfreight.

People and business easily outperform the government, and the government’s stodgy measurements of inflation.

The economics “profession” is trapped in a room filled with its own inflation farts. Get out of doors, and see the real world.

Growth is the goal, not a slavish to devotion to stability of an artificial and inaccurate index of prices.

It seems pointless to say that during periods of long-term stable growth, that NGDP targeting is about as good as price-level targeting. Isn’t that a mathematical identity.

It is the time of crises where NGDP has a stabilizing effect. It is also the case that NGDP is always easier to measure and thus to control to. As an engineer designing a control system it is a no-brainer as to which is better to target–NGDP.

I also got a hint in the Bankers statement that “make up” inflation to return to trend is excessive. I agree. The old trend-line is broken, because of permanently lost opportunity. But choosing a new trend is not hard.

All those mattress-stuffers and their simple minds are tough to overcome.

I think the goal should be a macroeconomic environment most suitable for microeconomic coordination. I think slow, steady growth of expenditure on output is the least bad option.

I think a growth path of spending consistent with the trend growth path of potential output will generate stable prices on average. I am very skeptical that a faster growth rate, that generates persistent trend inflation does any good.

Helping central banks continue with interest rate targeting by making their target higher is not a benefit.

Creating a culture of “cost of living” pay increases is not a benefit.

What we are looking for is a signal of monetary disequilibrium, or more importantly, a matching of demand with the productive capacity of the economy. Capital goods and intermediate goods count too.

If we imagine a situation where capital goods prices (or commodities prices) are being pushed up by an excess supply of money, but consumer goods are not effected, we are looking at a situation where there is an excess supply of money that has yet to impact consumer goods. Not a good thing.

Similarly, if an excess demand for money is putting downward pressure on commodities, or capital goods, but hasn’t effected consumer goods and services yet, monetary disequilibirum is disrupting production.

Of course, prices X production is better yet as a signal of monetary disequilibrium–all output, and not just consumer goods and services.

“In normal times, these greater stabilization benefits are not likely to be particularly important … apart from lower bound episodes, the gains from better exploiting the expectations channel are likely to be modest.”

A central banker saying this amid the Great Recession brings to my sorry mind the image of a man in a Fire Chief’s helmet saying…

“In normal times, the benefits of fire insurance are not likely to be particularly important … our research shows the value of such benefits only rarely match the premium cost”

I am not sure what our disagreement is, if any (also, remember, I do not have a Phd.). I suspect we disagree at the margins.

Perhaps you use words like “slow, steady” to mean 3 percent-4 percent annual increase in real GDP. I probably agree, but towards the upper end.

I use words like “moderate inflation” to mean anything under 5 percent, and perhaps you mean under 3 percent.

I have to say, if you admit that even measuring inflation is a bit of a subjective art, and not a science, then should we be so concerned about “inflation”?

Government-defined inflation is, after all, only a artificial and necessarily subjective and inaccurate measure of prices. It may overstate inflation, perhaps by one or two percent. If we target 2 percent official inflation, then we may be actually targeting deflation, which we know is extremely dangerous.

Better to burn a little hot, I’d say.

Also, you say “I am very skeptical that a faster growth rate, that generates persistent trend inflation does any good.”

Sheesh! You mean to say if we have a permanently higher real growth rate in GDP, but that such a high real growth rate generates inflation, then you are against it? (Or are you speaking to growth rate in money supply?)

This seems to be saying the need for stable prices trumps real growth. I would have it exactly opposite. I will tolerate some inflation to have robust growth—especially inflation as measured by an artificial, subjective nominal index.

I will say it again, I cannot fathom this obsession with inflation. Yes, hyper-inflation is destructive, just as eating too much and obesity is. The answer is not anorexia.

Woolsey, I want to say I enjoy your blog, and your friendly commentary, and I look forward to more comments from you. I think we are on roughly the same team, and if not—hey, conversation without debate is boring.

But I wish the economics profession would pay as much attention to the very real and present situation in Japan as much as the Weimar Republic or Argentina etc.

There just seems to be a need to issue long-faced sermons about inflation, but no equal urge to lecture sonorously about the evils of deflation. But what deflation has done to Japan is horrifying. You want your property to lose 80 percent of its value? Stocks down 75 percent? Wages down 15 percent? Industrial production down 20 percent? And no exit yet?

Has 5 percent inflation ever hurt like that? Even the Volcker’s crackdown on double-digit inflation in the 1980s caused a much smaller recession than the one we just endured.

The USA deflationary-recession of 2008-9-10 was much more grievous than the (necessary) Volcker recession.

“It is the time of crises where NGDP has a stabilizing effect. It is also the case that NGDP is always easier to measure and thus to control to. As an engineer designing a control system it is a no-brainer as to which is better to target-NGDP.”

The real reason to have NGDP is because crises don’t happen. Sure you might get a supply shock here and there, but generally speaking, you don’t get a lot of over heating when you piss on booms at 4.5%.

I think the discussion between Benjamin Cole and Bill Woolsey really encapsulates this issue nicely. The assumption I’ve operated under was that the issue is expectations. In a complex economy, businesses enter into contracts with creditors, suppliers and workers. Those contracts may be long term and not easy to modify. So if expectations are suddenly dashed, productive businesses may go out of business that would not have gone out of business otherwise.

So you could have a functioning economy where the price level goes up 7% a year forever, or down 7% a year forever, and you’d get the same real growth as people would enter contracts based on those expectations. If that’s true, it seems to me we’d be better off with roughly a 0% average change in the price level and Woolsey’s 3% NGDP growth because it’s simpler for the average person to understand. There would have to be a reasonable transition so expectations can adjust.

However, I don’t know if that assumption is valid. Many economists seem to think 2% is the optimum. If Benjamin Cole is correct that we can get higher real growth indefinitely from a higher NGDP growth, then we should obviously do that – higher standards of living is the goal. Money is a man made tool, meant to serve man – not the other way around.

My question is – do we know the answer to that question? Milton Friedman taught us to look at the data. If our assumptions don’t match the real world, it’s the assumptions that need to go, not the real world.

Your hypothesis of tight money = neo-liberal reform needs a dose of reality. We’ve had tight money for the last three years and I don’t see where the predictions are coming true, except in a handful of states. We have more Federal employees now than ever before, bigger government than ever before, and by the time Obama’s term is up, public debt will have almost doubled. In the meantime, we’ve had a massive taxpayer revolt and the Occupy Wall Street counter-movement. It seems beyond logic to be so sure tight money is a such blessing when we see the kind of destabilizing effects that come with it. It’s anything but certain how it will conclude especially with all the infighting going on in the GOP. There is a greater than average chance the GOP will end up screwing the pooch because a house divided cannot stand, nor win an election.

The Tea Party is all but dead, the remnants of which are only to be found in a quivering mass of hypocrisy in Camp Romney, with a few tin-foil-hat outliers hanging with the OWS crowd. The SoCons are taking over the GOP, and you’ll get who they pick for the presidential nominee. Go ahead and try beating Obama with Rick Santorum and win congress at the same time – it’s not going to happen and thus your attempt to get the solution you want by advocating the financial destruction of people who may not have otherwise met that fate is nothing but a national heartache with quite the opposite consequences than you intend.

What was happening the last time we had any serious attempt at reform of pensions, tax code, entitlements, the Federal workforce, etc… – what was happening in 1980? Oh gee, double digit inflation. So if there is any correlation between the stance of monetary policy and the implementation of neo-liberal reform, it must be high inflation!! Really, I think you should be supporting 19% NGDP growth so we can get another Reagan and finally get the big government mess cleaned up; or we can stick with Depression Era economics and get page after page of economic solutions straight out of FDR’s playbook, which appears to be far more consistent with what is actually taking place (including the complete marginalization of the GOP).

You seem like a really smart guy, but this idea you keep pushing is quite bizarre and has no historical basis. In fact, from a historical perspective, the opposite is true. Maybe it’s time you jump on board with Benjamin Cole to get those printing presses fired up until we’re all dancing naked in the streets with $100 bills flying through the air like confetti.

I don’t favor stabilizing a price index. I favor growth of nominal expenditure consistent with the long run trend of the growth of productive capacity.

I favor “inflation” of nominal incomes at a rate equal to the long run growth rate of real income.

I see little benefit to more rapid growth in nominal expenditures.I see little benefit to slower growth in nominal expenditures.

A stable price level for final goods and services is a consequence of that rule, not the goal.

With supply shocks, or even persistent productivity slow downs (or speed ups) the result would be changes in the price level or even persistent inflation or deflation.

Negation:

The slower the deflation rate, the less profitable the issue of hand to hand currency. If deflation is too rapid (and 7% is way too much, I think,) it will be impossible to issue it. If the monetary system is based on hand-to-hand currency, the result would likely be a disaster. With deposit only monetary systems, nominal interest rates can all be negative. Maybe -4% or -3% with 7% deflation.

Mark Sadowski,
first link: when our heart is torn between two ‘places’ that don’t understand each other – such as country and city, we tell ourselves that home is everywhere.
second link: the movie trailer – maybe that cure would work for my bursitis!

1. Currency – Go to electronic currency. It can have either a negative, positive or zero interest rate. Gives you more policy flexibility.

2. Measuring inflation – Listed companies all break down changes in sales by price and volume. Pick the right basket of companies and you can perfectly replicate the CPI or the GDP deflator or create a better index. Take your pick. A side benefit is that you measure inflation with a $200 computer tracking corporate earnings reports and get rid of a bunch of redundant statisticians at the BLS.

3. Please stop talking about inflation when discussing monetary policy. Any time you talk about inflation you are going to get opposition from the No-Nothing right and the inflation hawks. Focus on NGDP and just call it “Economic Output”. Politicians and the public don’t have a clue when you talk about Nominal GDP, but nobody is against “Stable Growth” (i.e. level targeting) of “Economic Output”. If somebody wants to draw a distinction between real and nominal let them lose the nomenclature war by forcing them to refer to RGDP as “Inflation Adjusted Economic Output.” If you don’t like “Economic Output” at least stop talking about Nominal and Real. NGDP should be called just plain old GDP and RGDP should be inflation adjusted GDP. Let the other guys use the “I” word when they’re talking about their policy goals.

4. And finally for the umpteenth time, you are going to have a hard time selling it if you keep telling everyone the way to achieve “Stable Growth” (level targeting) of “Economic Output” (NGDP) is by adjusting the base. Every time you do this, you run into the argument about the government printing money. Instead recommend that the Fed control the broader monetary aggregates directly by regulating maximum and minimum bank asset/equity ratios. Then your argument is not that the government is printing money but rather that the Fed is forcing the greedy banks to stop hoarding cash during the recession.

You referred me to Mishkin and the 12 or so (can’t remember the exact number) of mechanisms by which monetary policy works. I challenge you to name one of the mechanisms that won’t work as well or better by directly controlling the broader monetary aggregates instead of trying to influence them by manipulating the base.

As Woodfordian logic would have it, a key appeal of NGDP-level targeting is that by compensating for past deviations from desired levels-i.e., by introducing more dependence on history-it would better harness the power of expectations to stabilize the economy.

Woodford’s logic is unsound, because no seller sells into, and no investor invests into, “aggregate demand.” They sell and invest into individual demands, and within those individual demands, they sell and invest by exploiting differences in sub-demands and prices.

Aggregate demand is an effect of a healthy, well-structured economy that tends to be line with sovereign consumer preferences. It is not a cause for it. Increasing money artificially by fiat, into certain parts of the economy (e.g. the loan market first as is typical of a central banking system), isn’t even an “aggregate demand” policy. It is a policy that by the nature of the case increases particular demands in particular areas of the economy first before others, and thus brings about a revolution in the structure of production. Money that leaves the banking system along with artificially low interest rates (the latter as a result of the Fed increasing bank reserves to influence them to loan more money ex nihilo), doesn’t affect the economy’s aggregate spending equally across all stages of production. It affects those stages most sensitive to interest rates (the longest ranging capital intensive stages, and those companies producing and selling durable consumer goods).

If consumers aren’t voluntarily saving enough to make the expansions of these stages sustainable in the real sense, then these expansions are doomed to fail (see the dot com bubble, the housing bubble, and the current sovereign debt bubble which absorbed the garbage that previous inflation and previous artificially low interest rates have generated from the past).

The end result of the existing communist central banking system (which all you “market” oriented monetarists should know is one of the ten planks of communism in Marx’s “Communist Manifesto”) is either hyperinflation or universal price controls and socialist dictatorship. There is no other long term outcome. Inflation, and artificially low interest rates that result from lending money into existence, are not long term policy solutions for “steering the economy.” They have a finite shelf-life. The US dollar is kept alive by the military forcing oil producing nations to sell oil in dollars. The NY Fed alone secretly (not since secret any more) sent over $40 billion to Iraq from 2003-2008, to finance the war effort to ensure Iraqi oil continues to sell in dollars, rather than Euros. Prior to Gaddafi’s ousting, in 2008, the Fed sent tens of billions of US dollars to the Libyan central bank through one of the bank’s subsidiaries “Arab Banking Corp.” Did you know that after the US started bombing Libya, sometime in March 2011, they froze all of Libya’s assets, except Arab Banking Corp, which they have allowed to continue doing business in the US?

So Bill Woolsley you essentially think any inflation is anathema? I was just skimming Bernanke’s book on inflation targeting-called aptly enough “Inflation Targeting”-and even he says that if you have a zero target, missing it a little to the downside would be considerably worse than missing it a little to the upside. For this reason he argues against a zero target.

Interestingly to the argument that we had deflation in the gold standard era, he argues that today with credit being so much more intergral to the economy deflation is much more harmful than it was then.

DW is right, people don’t talk about Australia enough. This post on a well known Oz politics website gives lots of reasons (backed by numbers and pretty graphs) why policy wonks should talk about Australia more.

Scott: that is the other thing about Carney’s speech. If you are going to defend inflation targeting, then the Australian version of a targeted average inflation rate over the business cycle is surely worth discussing–it being a smashing success and all. (Possibly something to do with ending up stabilising growth in Py.)

I favor stable growth path of spending on output. This is a series of levels going into the future with the growth rate of the targets being 3% per year.

The 3% comes from the trend growth rate real GDP. All of these estimates do involve some estimate of inflation.

The consequence of these rule would be stable prices on average. However, if there is some adverse or favorable supply shock, the result would be an increase or decrease in the price level. Moving to that new price level would involve temporary inflation or deflation. If the supply shock was temporary, then when it reverses, the price level would return to its previous level and when it does that, there would be deflation or inflation that reverses the previous inflation or deflation.

If there is a persistent slow down in the growth of productive capacity, which it appears is happening now, then the effect will be persistent inflation. So, there could be decade of 1% or even 2% inflation. The price level just gets higher. If and when the growth of productive capacity returns to trend of 3%, the price level stablizes.

Similarly, a long period of extra high growth would result in a period of 1% or 2% deflation. The result would be a progressively lower price level. If and when the growth of potential output returned to trend, then the price level would stablize at that lower level.

If nominal GDP falls below target, to the degree that this results in any deflation, returning it to its target growth path would likely result in inflation.

On the other hand, if nominal GDP rises above target, to the degree this causes inflation, then returning it to target would involve deflation.

It is obvious that “any” inflation is not anathema to me.

What is the least bad trend for growth in spending? Equal to the trend growth path of productive capacity. The price level, inflation, and deflation all tend on what happens given that rule.

I have very little confidence that “you aren’t getting your cost of living raise” does much good in avoiding labor market disequilibrium. And worse, creating “cost of living” raises creates a framework where adverse supply shocks result in wage increases to compenstate for the loss of a cost of living.

Perhaps the unwillingness to cut wages involves some kind of irrationality that trend inflation can overcome. But I think the bigger effect is that it reflects a perceived need to reallocate labor in ordinary times. Firms in such bad shape that it must cut wages or cut employees, they should shrink. The employees should get new jobs somewhere else. That is a good rule of thumb.

Now, using monetary policy to prevent or reverse supply side inflation would create what is not a usual time. You are trying to get everyone to take lower nominal wages and force down the prices of most things to offset the increase in the prices of the good with an adverse supply shock. Nearly everyone should not be shifted anywhere.

And if there is an excess demand for money, so the decrease in wages is just to create an increase in the real quantity of money, there is no need to shift about about.

A signal to cut everyone’s wages is not a signal to reallocated labor.

But if there is a need to shift people about, and avoiding this requires wage cuts, and no one wants wage cuts and would rather see their employer close or just cut them, it is not at all obvious that trend inflation is the answer.

If we look at the normal turnover in the labor force, it is not at all clear that if growing nominal GDP (and potential output) is generating lots of new jobs, there is a need to keep people in their old jobs by reducing their real wages through trend inflation.

Anyway, I think there is a reason why the Fed was so adverse to saying it was trying to generate inflation. I think that there are plenty of people who think inflation is a force of nature that the Fed is fighting, and doing a good job at keeping it so low. The more people who understand that it is on purpose so that they can suffer wage cuts, the less popular it will be.

That still sounds like you’re pretty inlfation adverse to me. Again, even during The Great Moderation-a period that I view considerably less fondly than perhaps many others here-you did not see trend inflation that low.

If during the GM we saw inflation rates vacilate between 2-6% I don’t see why we need to say that even during a major slump like now we would want to make sure it goes no higher than 2% You’re phrasing it as “even 2%” indicates you find that very high.

Evidently you envision mild inflation during slumps and mild deflation during booms which together would give us roughly zero inflation trend over time.

Again, not that he is the first and last authority on it but even Bernanke in a book about inflation targeting sees deflatin as particularly undeseriable and I think he’s right about that. For this reason he argues against an inflation target lower than 2%

Before you argue for the Classical age of the Gold standard as proof that delfationary eras can be prosperous, his point is that in the modern economy deflation is likely much more harmful than then as it is so much more depenedent on credit. The Gold Standard in any case was hardly a golden age-between 1873 and 1913-the start of the Federal Reserve system-the economy was in recession roughly 1 out of ever 2 years, to say nothing about the regular bank panics.

Incidentally, while Bernanke is obviously very well disposed to Monetarism, he does say in this same book that despite all the talk about having a rule based rather than a discretionary based monetary policy, the reality is that all monetary policy by definition must be discretionary-he does call for some basic framework for this discretion.

As to your point, Bill, about an “unwillignness to cut wages” who exactly is willing or unwilling? Other than government employees how can anything be done to guarantee wage cuts? This is set by the market.

I am to be sure considerably more skeptical than you that wage cuts are as stimuluative as you may think but as Scott himself has talked about recently, wages are fairly sticky.

For all that the wage increases during this recovery have been virtially nil-much less than in previous crises- so there’s little to be feared that workers are being overpaid right now. Years of coming down on the unions-starting with Reagan and the airlines in the early 80s- seems to have worked.

Bernanke’s worries about deflation are driven by his devotion to having the central bank target short and safe interest rates in an environment of inflation targeting. One the overnight rate is cut to zero, then if the expected inflation rate is zero, the real rate is zero.

If the expected inflation rate is 2% and the nominal rate is zero, the real raet is negative 2%.

I don’t favor targeting interest rates or inflation.

If real GDP is growing 5%, so there is deflation of 2%, the problem of the real rate needing to be 0 or less will not exist.

If nominal GDP has fallen below target, and the price level has fallen, then there is no committment to keep the price level at the lower level. Quite the contrary, there is a committment to get nominal GDP back up to target, even if the result is inflation. So, for example, if the price level has fallen 2%, then getting nominal GDP back to target will likely generate 2% inflation, and so a 0% nominal rate would imply a -2% real rate.

There is no notion that nominal GDP should be stay at the low level and the inflation rate stay 0, (the price level stay at its reduced level) and so worries that a zero nominal rate implies a zero real rate and that is too high to avoid futher decreases in nominal GDP are misplaced.

It is all being driven by inflation targeting.

The further nominal GDP gets below target, and the further the price level falls, the higher the inflation rate implied by the return, and the more negative a zero nominal interest rate.

But then, I don’t favor targeting short rates anyway. If nominal GDP is below target, then the Fed needs to expand the quantity of money enough to get it back to target. What happens to short term interest rates is mostly irrelevant. I do think there are reasons to believe that if people don’t find the Fed credible, it would have to buy longer term and riskier securities. That would drive down their yields. But even that is not likely. The most likely result of a below target nominal GDP is that the expected inflation of a recovery would slightly raise nominal and real interest rates.

But really, it all depends on the fundamental cause of the drop in nominal GDP.

Of course, I take a rather radical view and think that hand-to-hand currency should be privatized. In such a scenario, the interest rate on short and safe assets can be negative if necessary to clear the markets for those assets. The interest rates that true private investors receive (that is, not goverment guaranteed investors) and the interest rates the rest of us pay, would almost certainly remain well above zero.

But those of you who insist that the government has to make hand-to-hand currency the basis of the monetary and finanical system, well, that implies that sometimes the issuer has to purchase risky finanical assets. I don’t favor imposing a cost on currency holders year in and year old to avoid this occassional problem.

I don’t favor wage cuts to stimulate the economy. If favor slow steady growth in nominal GDP. The effect of this will be growing nominal wages.

However, the average growth of nominal wages will involve some wages growing more than average and others growing less than average.

Sumner is arguing that firms will lay people off rather than cut their nominal wage. And so, the lowest growth rate of nominal wages will be zero.

With nominal GDP growing at 3%, the lowest growth rate of real wages would also be zero in normal times. People in jobs would be laid off rather than be given lower real wages.

In nonnormal times, such as if productive capacity is growing only 2%, then the lowest rate real wage growth is -1%, or at least, that is what a zero growth rate of nominal wages generates because of the 1% inflation.

If some sudden increase in the price of gasoline, for example, results in a caculated inflation rate of 5% for a time, then average real wages would fall too.

Again, normally the average of nominal wages is growing as is the average real wage. The question is what is the lowest growth rate of real wages for an individual if real GDP is growing at trend and firms never cut nominal wages rather than let people go.

While I am sure there are many examples, suppose a firm is losing demand. It can stay in business by cutting prices. If can afford to cut prices if it cuts wages. The workers keep their jobs, but earn less.

But if no firm can cut wages, this isn’t possible. Firms losing demand keep pay the same. They can’t cut prices. They must reduce production and lay off workers.

This is in a context where demand is growing 3% on average with some firms having demand grow more than 3% and others having demand grow less than 3%, and some, of course, actually having demand shrink.

My view is that the workers laid off in the shrinking demand industry should get new jobs in the growing demand industries–particularly ones where demand is growing more than average.

Now, if demand grows 5% in nominal terms, then fewer firms will have shrinking demand in nominal terms. Of course, those where nominal demand is constant (shrinking in real terms) or even growing a low amount (say 1%) and so shrinking in real terms, will be able to maintain production by keeping prices stable or rising a low amount. They can afford that by not increasing their workers pay at all, or raising it a small amount.

The relative price of the product falls, and the worker’s real wages fall. And so employment and production are maintained.

Of course, there will be a tendency for the workers to leave this industry and go where their wages keep up or actually exceed inflation. So, there are quits, and the firm can’t find replacement workers.

Of course, we can get into individual compensation–slacker joe gets no raises, so his real wages are falling, and because we have more money each year and his pay becomes a smaller part of our budget, we keep him on anyway. This is better than firing him for being a slacker. He does produce something. But if we cut his wage, he would be mad at us. So, in a noninflationary environment, where budgets are tighter, we would have to let slacker joe go.

Maybe slacker joe should get another job.

And, by the way, I think that it is certainly the case that wages in a particular trade are lower, it does stimulate employment in that particular trade.

I am pretty sure your doubts about whether lower wages stimulate is about lower average wage payments stimulating greater aggregate employment. Given nominal expenditure on output, they do, but the argument would be that lower average wage payments might reduce nominal expenditure on output. But that really isn’t at issue here.

dtoh, I agree that I should stop talking about inflation, indeed I’ve made the point many times, but keep sliding back. I still think you need to adjust the base, capital requirements can slightly impact NGDP, but not that much in normal times (when rates aren’t at zero.)

Electronic money would end the zero rate trap, but a cashless society is decades away.

Mike Sax, Payroll tax cuts create the need for future distortionary taxes. They are costly for the same reason that Krugman used to argue the Bush deficits damaged the economy. Krugman would argue that deficits boost growth in the current situation. Fine, but if monetary policy can do the job just as well, it should be the first line of defense.

Canada did have a recession in 2009, and they currently have fairly low inflation.

Scott,
You said “I still think you need to adjust the base, capital requirements can slightly impact NGDP, but not that much in normal times (when rates aren’t at zero.)”

The really, really important point is that the Fed would set both MINIMUM and maximum asset/equity ratios. This gives the FED total control to tell the banks how much assets they must hold or create. As an example by adjusting the ratio, the Fed could force all banks to increase the amount of consumer loans they hold by 14% by the end of the month. This gives them complete control of the monetary aggregates (and NGDP).

“Mark Sadowski,
first link: when our heart is torn between two ‘places’ that don’t understand each other – such as country and city, we tell ourselves that home is everywhere.
second link: the movie trailer – maybe that cure would work for my bursitis!”

Home is where you hang your hat.

As for my bursitis, it worked for me.

By the way, as for my “Tonto”, that is “Kringle”, he is my best friend.

Scott,
Of course the banks play an important role. When the Fed buys assets, they don’t buy them from you or me or even Calpers (CA Teachers Pension), they buy them from the banks. And they don’t pay for them in cash so anything they do goes through the banks. And if the banks for example sell Tbills and and just replace them with deposits at the Fed, you get an increase in the base which is totally sanitized and there is no impact on the real economy. The only way it has an impact is if the banks then go ahead and acquire other assets (e.g. make loans). This does a lot of things including increasing the supply of M1, reducing the cost of credit, etc.

If there were no banks, (i.e. just the Fed), the Fed would be dealing directly with the real players (businesses, pension funds, consumers) and you wouldn’t have the problem where bank intermediaries can just absorb an increase in the base without it impacting the real economy.

The price level is going to be determined by the supply of money…. i.e. the money which is actually being used for the transactions which make up GDP and this is not just MB but also M1, etc. To the extent that the FED controls the amount of assets held by the banks, it also controls the amount the banks borrow (including deposits and other components of the money supply) and thus it has a large degree of control over the price level.

Taking it one step further, assume an economy with no banks at all. Transactions are all done on credit with the Unit of Account initially pegged to the dollar or gold or anything else for that matter. A computer program would act as a clearinghouse to offset loans and have an algorithm to set individual interest rates and borrowing limits for everyone in the economy. Any time the agency responsible for monetary policy wanted to effect a change they would just adjust the algorithm.

That would be a very a straightforward and ideal monetary system. Instead what you have now is commercial banks intermediating the process and then the Fed intermediating the commercial banks so you end up trying to push on the very short end of a very long lever anytime you want to use monetary policy to impact the economy.

If rather than trying to impact bank behavior by adjusting the base, the Fed instead directly controlled the amount of assets which banks had to hold (by setting min and max asset/equity ratios), you would be one step of the way down the road to having a much more effective monetary policy.

And as I have continually mentioned you get around the political issue of having to deal with the inflation hawks and the No-Nothings who oppose “government printing money”.

Also if the Fed were to control asset/equity ratios by asset class not only do you have better control of NGDP, you also have some control of how NGDP growth breaks down (i.e. you can get more RGDP growth and less inflation).

Scott,
“Electronic money would end the zero rate trap, but a cashless society is decades away.”

We already have electronic money or at least we did yesterday when I paid my rent via the internet.

A cashless society IS decades away… or maybe never. But paper and metal cash will be gone much sooner than you think, and as soon as you have electronic cash you can start putting an interest rate on it.

Ok, Bill a lot to chew in all that-we could certainly get into some interesting discussions about mamy of them. My reason in saying you are inflation adverse is mostly because you like the idea of a 3% NGDP target which seems to me a little low.

Even based historically on the Great Moderation a 5.5% rate or so would be indicated. OF course Keynesian that I am I’d be happy to see it even slightly higher though I suspect that would defeat the purpose of many MMers at that point.

Bill, certainly no one worries about deflation in an economy so juiced that RGDP is growing at 5%

Still we haven’t seen RGDP growth at 5% along with 2% deflation in a long time. We had it in the 20s-a little, really deflation was not as much as 2% even then, it was fairly mild-but not recently.

The truth is that most of US history has had “price stability.” There were a few bouts of inflation associated with WWI and WWII-of course WWI was far worse with 4 straight years of 16% inflation followed by the 1921 double digit deflation-and deflation followed the periods of demobilization.

So there’s little precedent. The 70s were the only time we saw long term peace time inflation. So I consider concerns about inflation in the US rather overdone anyway.

As far as inflation in the 70s are concerned-to digress-I’m currently reading a book about the Cold War actually, but an interesting point is that Nixon’s closing the gold window and devaluation exploded the world money supply. I see Nixon’s move there as basically positive but this did a lot to contribute to world wide inflation too-the Great Inflation was not only an American phenomenon.

In any case you certainly seem a lot more concerned than I am about inflation-hence the low NGDP target. To be sure I’m no doubt a Keynesian outlier, if I had my way no one connected with monetary poliicy should even be allowed to breath the words “inflation concerns” right now. If you have any concern about inflation in this context you don’t even deserve to be a policy maker nor should you be listened to in any forum. Bulliard you’re fired. But I’m an outlier.

Though the 70s supposedly disproved Keynes the fact it that most of what we would consider the Keynesian era did not have inflation any higher than the Great Moderation

dtoh, I don’t agree. In an economy without banks transations would be done with cash. But in any case the importance of money is not because it’s used in transactions, but rather because it’s the medium of account. If apples were the mediam of account we’d all be studying orchard output–even if apples were not used in transactions.

The Fed does not always inject new money through the banking system. I’m told they sometimes buy bonds from non-banks. And during normal times 95% of the new money is currency, not bank deposits at the Fed.

If drug dealers hold more base money than banks, then drug dealers have a bigger impact on the CI than banks. It’s all about the supply and demand for base money.

Now I will agree that the current situation is different, as banks are holding large amounts of base money because of low rates and IOR, but that reflects bad monetary policy.

I agree with your second comment–with a cashless society you can having negative interest rates or positive interest rates.

Scott,
“But in any case the importance of money is not because it’s used in transactions, but rather because it’s the medium of account.”

Isn’t what we are interested in the ratio of the exchange media to the medium of account.

“And during normal times 95% of the new money is currency, not bank deposits at the Fed.”

I assume by “money” you mean base money and by “currency” you mean physical currency. I’m not sure the 95% is a relevant ratio. What you should be looking at is the ratio of currency to money used for transactions…. roughly speaking currency to checkable deposits. These are what impact demand.

“If drug dealers hold more base money than banks, then drug dealers have a bigger impact on the CI than banks.”

I don’t think anyone knows enough about the disposition of cash to say anything about this. The cash may all just be sitting in idle hoards in Moscow, Lagos and Bogata.

“It’s about the supply and demand for base money.”

Not ALL. You have to look at output (prices) as a combination of cash goods, goods paid for by check or wire, and credit goods. Changes in the base do not effect these equally. The role of banks is important for all of these but particularly for the latter two.

“Now I will agree that the current situation is different, as banks are holding large amounts of base money because of low rates and IOR, but that reflects bad monetary policy.”

Now YOU are using the lifeboat argument. The reason I argue for giving the Fed the ability to regulate asset/equity ratio is precisely because a) normal monetary policy runs into political constraints in during downturns, and b) in a really bad downturn the banks would go into panic mode and put everything the could into Fed deposits regardless of IOR, etc.

dtoh, You may want to move this to the newer post with the currency pictures, as I’m now stopping comment replies on anything more than 5 posts back. But a quick answer.

1. No it’s not the medium of exchange that impacts demand, it’s the medium of account. Gold discoveries in the 1900s were inflationary even though gold was rarely used for transactions. It was the medium of account.

2. If it sits in hoards in those 3 cities my point still stands. Those hoarding cash in those places (for whatever reason) have a far greater impact on US AD than the banks.

You said;

“Now YOU are using the lifeboat argument. The reason I argue for giving the Fed the ability to regulate asset/equity ratio is precisely because a) normal monetary policy runs into political constraints in during downturns, and b) in a really bad downturn the banks would go into panic mode and put everything the could into Fed deposits regardless of IOR, etc.”

It doesn’t run into political constraints in downturns, higher unemployment is very unpopular. We need a NGDP target whatever technique we use, and if we have an NGDP target, level targeting, we won’t hit the zero bound anyway–and any tool would work.

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.